What Is W-2 vs 1099?

The W-2 vs. 1099 distinction refers to the classification of workers as either employees or independent contractors — one of the most consequential decisions a business makes about its workforce. W-2 employees are on the company's payroll; the employer withholds income tax, Social Security, and Medicare taxes from each paycheck and pays the employer's share of payroll taxes (7.65%). The company issues a W-2 form at year-end summarizing wages and withholdings. Employees are also typically entitled to benefits such as health insurance, retirement plans, workers' compensation, and unemployment insurance.

Independent contractors — who receive Form 1099-NEC for payments of $600 or more — are responsible for paying their own self-employment taxes (15.3% on net self-employment income), maintaining their own insurance, and managing their own business expenses. The hiring company is not responsible for withholding taxes, providing benefits, or paying payroll taxes for contractors. This makes contractors less expensive on a direct cost basis, but the classification carries strict legal requirements.

Misclassifying employees as independent contractors is a serious legal risk. The IRS, Department of Labor, and most state labor agencies use multi-factor tests to evaluate whether a worker is truly independent: behavioral control (does the company direct how work is done?), financial control (does the worker have investment in their business, work for multiple clients, have opportunity for profit or loss?), and the nature of the relationship (is there a written contract, are there benefits, is the work integral to the business?). The California ABC test, used in California and several other states, applies an even stricter standard.